Jeff Flake | Congressman Arizona’s Sixth District

Phoenix, Arizona, Apr 17, 2005 - In the summer of 2002, after months and months of reports of corporate malfeasance and facing a campaign season in which politicians were being associated with Ken Lay, Bernie Ebbers, and the like, Congress passed a sweeping reform bill intended to improve corporate governance. The political and corporate worlds, both eager to restore public confidence in their respective institutions, hailed the Sarbanes-Oxley Act as a cure-all.

    The spectacle of Congress lecturing corporations on financial transparency should have been enough to make the public skeptical. In truth, some of Congress’ bookkeeping methods would make Enron executives blush.

    I’ve learned two important lessons since coming to Congress. First, Congress simply doesn’t work well when driven by crisis. Our hasty efforts to improve airport security after 9/11 gave us tens of thousands of new screeners who are now employees of the federal government, but has yielded little in terms of improved passenger and baggage screening. Travelers at airports nationwide have had plenty of time to ponder this mistake as they languish in long lines – lines that, in the case of Sky Harbor, were deliberately lengthened in a recent attempt to justify more employees.

    Second, when hastily prepared legislation passes by an overwhelming margin, it is often not because it has been thoroughly vetted and has earned consensus. I would argue that Sarbanes-Oxley, which passed the House of Representatives by a vote of 423 to 3, was as much an attempt to politically inoculate Congress as it was an honest effort to improve corporate governance. When I voted against it, I stated that the bill was so hastily crafted and overreaching that it was sure to create unintended consequences that could actually hamper economic growth. Tens of billions of dollars in compliance costs later, this has most certainly been the case.

    Public companies, particularly smaller companies, are telling Congress and the Security and Exchange Commission (SEC) that the enormously high costs of complying with the law are stifling innovation and job creation, dissuading private companies from going public and foreign companies from listing on U.S. stock exchanges, and discouraging entrepreneurial risk-taking.

    The provision of the bill that companies complain about the most – and most loudly – is Section 404. Section 404 mandates several internal control requirements and is intended to help combat fraud and prevent filing mistakes. Initially estimated at a price tag of under $2 billion, the actual costs of complying with Section 404 have risen to more than $35 billion, and small public companies have borne the brunt of that. Moreover, there is good reason to question whether these mandates will actually prevent the kind of massive fraud the overall bill is meant to curtail.

    Because smaller companies cannot afford internal auditors to prepare Section 404 filings, they must rely on external auditing firms. Many small businesses have claimed that some external firms have been overly aggressive in their compliance with Sarbanes-Oxley in order to pump up their fees. Companies have complained about having to pay for auditors to attend meetings in order to simply verify that meetings took place.

    Just how strongly Section 404 is squeezing small public companies can be illustrated by how fiercely the auditing industry is preparing for possible reforms of Section 404. PricewaterhouseCoopers have been taking out full page advertisements in financial journals and newspapers like the Wall Street Journal extolling the virtues of Section 404. While the provision has certainly caused a boom for the auditing industry, it's been largely at the expense of the companies that can least afford it.

    Aside from the auditing industry, which can barely keep up with demand, the new regulations have saddled companies with costs that get passed along to shareholders and consumers.

    Several public companies have already declared plans to go private, citing the Sarbanes-Oxley Act among the reasons for doing so, and many private companies have voiced hesitation about growing their companies by going public. This is a troubling trend for anybody concerned about the long-term economic growth.

    Equally troubling are statements from technology companies that the high compliance costs of Sarbanes-Oxley are stifling innovation. Tech companies, which often struggle to break even as they get off the ground, are forced to drain resources and capital on compliance, making them unattractive to investors. Technology companies have fueled international economic growth and for regions like Arizona that host burgeoning tech industries, the prospect of hampering this industry is not a pleasant one.

    While it is understandable that we in Congress are reluctant to admit that we made a mistake, it will only be a matter of time before the cries from businesses grow too loud to ignore. Global competition is tough enough without saddling business with excessive costs.

    I am currently drafting legislation that will address Section 404 internal controls. Obviously, businesses will continue to best serve their shareholders and the public by demonstrating that their books add up. However, Congress made a mistake by applying a one-size-fits-all approach to a problem with varying dimensions. It is time that we fixed that mistake before the damage created by our “solution” forces Congress into crisis mode.